Life Cycle and Wealth Cycle in Financial Planning

Financial planning is a critical aspect of managing one's financial well-being and securing a stable future. It involves understanding and managing both the life cycle and wealth cycle to make informed decisions about savings, investments, and expenses. Let's delve into each concept:

Life Cycle

The Life Cycle refers to the various stages or phases that an individual goes through in their life, each characterized by different financial needs, goals, and responsibilities. These are the normal stages that people go through, viz.:

Childhood

During this stage, focus is on education in most cases. Children are dependents, rather than earning members. Pocket money, cash gifts and scholarships are potential sources of income during this phase. Parents need to groom children to imbibe the virtues of savings, balance and prudence. Values imbibed during this phase set the foundation of their life in future.

Young Unmarried

The earning years start here. A few get on to high-paying salaries early in their career. Others toil their way upwards. Either way, the person needs to get into the habit of saving. The fortunate few who start off well have to avoid falling into the trap of unsustainable life styles.

Equity SIPs and Whole-life insurance plans are great ways to force the young unmarried into the habit of regular savings, rather than lavish the money away.

This is the right age to start investing in equity. Personal plans on marriage, transportation and residence determine the liquidity needs. People for whom marriage is on the anvil, and those who wish to buy a car / two-wheeler or house may prefer to invest more in relatively liquid investment. Others have the luxury of not having to provide much for liquidity needs. Accordingly, the size of the equity portfolio is to be determined.

Young Married

A cushion of assets created during the early earning years can be a huge confidence booster while taking up the responsibilities associated with marriage.

Where both spouses have decent jobs, life can be financially comfortable. They can plan where to stay in / buy a house, based on job imperatives, lifestyle aspirations and personal comfort. Insurance is required, but not so critical.

Where only one spouse is working, life insurance to provide for contingencies associated with the earning spouse are absolutely critical. In case the earning spouse is not so well placed, ability to pay insurance premia can be an issue, competing with other basic needs of food, clothing and shelter. In such cases, term insurance (where premium is lower) possibilities have to be seriously explored and locked into.

Depending on the medical coverage provided by the employer/s, health insurance policy cover too should be planned. Even where the employer provides medical coverage, it would be useful to start a low value health insurance policy, to provide for situations when an earning member may quit a job and take up another after a break. Further, starting a health insurance policy earlier and not having to make a claim against it for a few years, is the best antidote to the possibility of insurance companies rejecting future insurance claims / coverage on account of what they call “pre-existing illness”.

While buying an insurance policy, there has to be clarity on whether it is a cashless policy i.e. a policy where the insurance company directly pays for any hospitalization expenses. In other policies, the policy-holder has to bear the expense first and then claim re-imbursement from the insurer. This increases the liquidity provisions that need to be made for contingencies. All family members need to know what is covered and what is not covered in the policy, any approved or black listed health services provider, and the documentation and processes that need to be followed to recover money from the insurer.

Married with Young Children

Insurance needs – both life and health - increase with every child. A level of insurance cover, and mix of policies that would help the family maintain their lifestyle in the event of any contingency is vital.

Expenses for education right from pre-school to normal schooling to higher education is growing much faster than regular inflation. Adequate investments are required to cover this.

Married with Older Children

The costs associated with helping the children settle i.e. cost of housing, marriage etc are shooting up. If investments in growth assets like shares and real estate, are started early in life, and maintained, it would help ensure that the children enjoy the same lifestyle, when they set up their independent families.

Pre-Retirement

By this stage, the children should have started earning and contributing to the family expenses. Further, any loans taken for purchase of house or car, or education of children should have been extinguished. The family ought to plan for their retirement – what kind of lifestyle to lead, and how those regular expenses will be met.

Retirement

At this stage, the family should have adequate corpus, the interest on which should help meet regular expenses. The need to dip into capital should come up only for contingencies – not to meet regular expenses.

The availability of any pension income and its coverage (only for the pensioner or extension to family in the event of death of pensioner) will determine the corpus requirement.

Besides the corpus of debt assets to cover regular expenses, there should also be some growth assets like shares, to protect the family from inflation during the retirement years.

Determining how much corpus you require to lead the lifestyle you want after retirement involves considering various factors. Here are some easy questions to help you ascertain the required corpus.

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Wealth Cycle

This is an alternate approach to profile the individual wrt to investment. The stages in the Wealth Cycle are:

Accumulation

This is the stage when the individual gets to build his wealth. It covers the earning years of the individual i.e. the phases of the life cycle from Young Unmarried to Pre-Retirement.

Transition

Transition is a phase when financial goals are in the horizon. E.g. house to be purchased, children’s higher education / marriage approaching etc. Given the impending requirement of funds, individuals tend to increase the proportion of their portfolio in liquid assets viz. money in bank, liquid schemes etc.

Inter-Generational Transfer

During this phase, the individual starts thinking about orderly transfer of wealth to the next generation, in the event of death. The individual should understand various inheritance and tax issues, preparing Will and validating various documents and structures related to assets and liabilities of the oneself.

It is never too early to plan for all this. Given the consequences of stress faced by most individuals , it should ideally not be postponed beyond the age of 50.

Reaping / Distribution

This is the stage when the individual needs regular money. Hence, people in this stage need to have higher allocation to income generating assets. It is the parallel of retirement phase in the Life Cycle.

Sudden Wealth

Winning lotteries, unexpected inheritance of wealth, unusually high capital gains earned – all these are occasions of sudden wealth, that need to be celebrated.

However, given the human nature of frittering away such sudden wealth, individual s should channelize the wealth into investments, for the long term benefit.

In such situations, it is advisable to initially block the money by investing in a liquid scheme. An STP from the liquid schemes into equity schemes will help the long term wealth creation process, if advisable, considering the unique situation of the investor. Even if there is a need to invest in equity for the purpose of wealth creation, a large lump sum investment may be avoided.

Financial Planning Tools

The financial plan preparation becomes simpler with the aid of financial planning tools. These help not only in estimating the cash flow requirements and preparing the financial plan, but also ongoing monitoring of the portfolio.

A few mutual funds and securities companies provide limited financial planning tools in their websites.

Checklist of Learning Points

Financial planning is a planned and systematic approach to provide for the financial goals that will help people realise their aspirations, and feel happy.

The objective of financial planning is to ensure that the right amount of money is available at the right time to meet the various financial goals of the investor.

An objective of financial planning is also to let the investor know in advance, if some financial goal is not likely to be fulfilled.

A “goal-oriented financial plan” is a financial plan for a specific goal. An alternate approach is a “comprehensive financial plan” where all the financial goals of a person are taken together.

Understanding the life cycle and wealth cycle is fundamental to effective financial planning. By recognizing the unique challenges and opportunities presented at different stages of life, you can make informed decisions that pave the way for financial security and prosperity. Utilizing accessible financial tools empowers you to manage your finances, build wealth, and plan for a brighter future. Remember, the key to success lies in continuous learning, adapting to changing circumstances, and seeking professional advice when needed.